Improving Cash Flow Management: A Guide for Small Businesses
Most small business owners are familiar with this sobering statistic: the majority of small businesses fail within the first five years. Often, the problem isn't ineffective marketing or insufficient market demand—it's a lack of cash.
According to SCORE, 82% of small businesses fail due to cash flow problems.
To help you avoid that fate, we prepared this step-by-step guide to help you gain control over your cash flow management.
Step 1: Understand Your Cash Flow Drivers
To manage cash effectively, start by identifying what’s leading your cash flow.
Revenue sources
Where is your income coming from?
Top-performing companies focus on increasing sales over time by expanding their customer base, launching new products or services, and optimizing their sales strategies.
But keep in mind: increasing sales can sometimes exacerbate cash flow problems if you need to pay to produce more products, maintain higher stock levels, or pay for labor to sell the product or deliver the service.
Accounts receivable
Accounts receivable is the money customers owe you for products or services you've already delivered.
Effectively managing receivables can accelerate cash flows, so make sure you have:
Clear credit policies
A streamlined process for invoicing customers
Processes for following up on overdue payments
Taking stock of these elements helps you build a complete picture of your cash inflows.
Step 2: Track Cash Outflows
In simple terms, cash outflows are any money leaving the business. Understanding your cash outflows helps you anticipate challenges before they arise. Take stock of:
Accounts payable. Know which vendors need to be paid, the payment terms, and how those timelines align with your cash inflow. Taking advantage of payment terms like net 30 or net 60 without incurring penalties allows you to retain cash in your business longer and gain additional flexibility.
Payroll obligations. Employee wages are one of the largest recurring expenses for most companies. Do you have enough liquidity to meet payroll obligations without disruption?
Capital expenditures. Investing in long-term assets like equipment, property, and technology is necessary for growth, but it can tie up cash. Make sure you prioritize purchases based on potential returns and consider financing options.
Consider leveraging technology to automate and streamline your accounts payable process and avoid unnecessary cash outflow pressures.
Step 3: Predict Future Cash Flow with a 12-Month Look Forward
It's easy to assume that having a positive cash flow today means you'll have a healthy cash flow tomorrow. But a slow sales period, late-paying client, or unexpected expense can easily mean you don't have enough cash coming in to cover your day-to-day expenses.
A 12-month forecast lets you anticipate these cash flow fluctuations and plan accordingly.
So, how do you create one? Here are the five steps involved:
Start with your opening cash balance
Estimate the amount of cash you'll receive in the coming month from sales and collecting receivables
Calculate the cash going out in the coming month from payables, salaries and wages, operating expenses, tax payments, asset purchases, loan payments, etc.
Apply the cash flow formula: Cash flow = Beginning cash + cash inflows - cash outflows
Perform this forecast for the next 12 months and make it a rolling forecast, meaning when one month's results are finalized, your forecast slides forward by one month.
This lets you predict future cash shortages and plan for them by building up cash reserves, tightening credit policies, encouraging early payments, or securing a line of credit.
Step 4: Monitor Your Cash Flow Projections and Adjust Monthly
Your forecast will only remain useful if you monitor and adjust it on an ongoing basis.
Each month, compare your revenue to expenses and cash inflows to cash outflows. If your outflows exceed inflows, make adjustments to either reduce costs or increase income.
Step 5: Embrace Cash Flow Tools
Unfortunately, small businesses have limited options for cash flow management tools. But there are some solutions worth exploring.
Many small business accounting software platforms include cash flow management features or integrate with cash flow management apps.
If specialized tools are out of budget, consider a simple spreadsheet model to help you visualize your cash flow. Microsoft has a small business cash flow forecast template for Excel, or you can download a similar template from SCORE.
The key is consistently using whatever tool works for your business.
Step 6: Work with a Trusted Advisor
An advisor can add tremendous value to your cash management process by offering external perspectives on cash flow trends and providing actionable insights.
For example, your advisor can help you run “what if” scenarios. What if your largest client is late on payment? What if an unexpected repair derails your plans? Plugging these variables into your forecast helps you prepare for contingencies.
They can also help you evaluate your options for dealing with negative cash flow. For example, they might help you decide whether to draw on a line of credit, renegotiate vendor terms, or delay a non-essential expense to safeguard your cash position.
Step 7: Track Metrics and Improve Over Time
Regularly tracking metrics can help you stay on top of your cash flow. Here are a couple of metrics to consider.
Cash conversion cycle (CCC)
CCC is a metric expressing how many days it takes to turn your investments in inventory into cash from selling the product.
To calculate your CCC, you need to first calculate three other metrics:
Days inventory outstanding (DIO): average inventory cost/cost of goods sold x number of days
Days sales outstanding (DSO): accounts receivable x number of days/total credit sales
Days payable outstanding (DPO): accounts payable x number of days/cost of goods sold
Once you have these figures, you can calculate your CCC with the following formula:
CCC = DIO + DSO - DPO
The shorter your cash conversion cycle, the better you are at selling inventory and recovering cash from those sales.
Operating cash flow (OCF)
Operating cash flow measures the money coming in from your core operations. It doesn't include revenues from interest or investments.
Here's the formula for calculating OCF:
OCF = Net income + non-cash expenses + change in working capital
Ideally, your OCF should be enough to support your business activities on its own without additional loans or infusions of capital from shareholders.
Take Control of Your Cash Flow Management
Cash management is one of the most vital—but often overlooked—functions of running a successful small business. With a detailed understanding of your inflows and outflows, a realistic forecast, and guidance from a trusted advisor, you can build a resilient financial foundation for your business.
Ready to improve your cash flow management? Contact Slate today to schedule a consultation and get started on achieving your financial goals.